529 plans are one of the most popular college savings options, but many people wonder if these funds can be used for college debt. Learn more from our 529 experts.
Even with the benefit of savings and financial aid, students across the country wind up with mountains of debt after finishing college, leaving many college grads to wonder how they can best pay off their student loans. As one of the most popular ways to prepare for college, 529 plans come with a raft of benefits, but do any of these benefits apply to students struggling with debt? If you have a 529 plan with funds left over after college, you might be wondering, “Can I use a 529 plan to pay off student loans?” To find out the answer, keep reading as the team at Sootchy addresses this important topic.
Given their tax-free status and the returns they can generate, 529 plans are a favorite for those looking to pay for higher education, but their uses are strictly defined by plan administrators and federal law. Each of the three types of 529 plans – education savings plans, prepaid tuition plans, and ABLE accounts – have their own acceptable uses, known as “qualified distributions;” we’ll look at some of the acceptable uses of 529 plans below:
The most rigid of 529 plans is the prepaid tuition plan, which allows families to put money toward tuition at a public school in their state. Ideally, the returns on this investment will allow parents to effectively lock in the cost of college at today’s rates, but the downside is that prepaid tuition plans have only a single use that is considered a qualified distribution: to pay for tuition and mandatory fees. In other words, these plans cannot help pay off student loans.
This type of 529 plan is one of the more flexible options in a number of ways. For one thing, someone with a 529 college savings plan can determine how their money is invested and change their portfolio at will; similarly, they can use the funds for a number of different educational expenses, such as housing or books, rather than just tuition.
The third and final type of 529 plan, the ABLE account, is intended only for those with a disability. Otherwise, this plan functions very similarly to an education savings plan, and it comes with even greater flexibility. Qualified distributions for ABLE accounts include things like medical costs and financial management services, in addition to higher education.
As long as you have a 529 college savings plan or an ABLE account, not a prepaid tuition plan, odds are you’ll be able to treat your student loan payments as a qualified distribution, a policy that was instituted in 2019 via the Setting Every Community Up for Retirement Enhancement (SECURE) Act. However, not every student loan is eligible for this treatment, and there are limits on how much can be spent toward student debt; let’s take a closer look below.
The SECURE Act specifies that only payments toward the principal or interest on a qualifying loan can be made tax-free from a 529 plan. To be counted as a qualifying loan, your debt must have been incurred only to pay for college; the loan can’t have been used for other things, such as lowering the balance on a credit card. Unfortunately, any interest paid out of a 529 plan cannot be used for the student loan interest deduction.
Although paying off student loans with the tax-free gains in a 529 account may sound like an ideal way to reduce your debt, there is a notable limit on how much money you can use in this way. Each beneficiary of a 529 plan can put up to $10,000 from a 529 account toward student loans in their lifetime, and each of their siblings gets the same benefit. However, the owner of a 529 plan can change the beneficiary of their account at any time, so families with several children may be able to work around this limit to a certain extent.
For students with relatives who want to contribute to their college education, the use of a 529 plan comes with pros and cons: On one hand, any money put toward tuition is less you’ll need to get from student loans, but on the other, 529 distributions from a non-parent relative could seriously impact your Free Application for Federal Student Aid (FAFSA).
With the new student loan provision created in the SECURE Act, however, grandparents, aunt, uncles, cousins, and family friends all have the opportunity to lend a hand without hurting a student’s chances of federal financial aid. Once the student in question has graduated, relatives are free to give as much as they like – up to that $10,000 limit – with the goal of reducing the burden of debt on their loved one.
For Americans of all ages, the weight of student loans can be a crushing burden to bear, but help is available in the form of 529 plans. Whether you’re looking out for a current or future student, it’s never too late to open an account and start saving for the future. Learn more about the benefits of 529 plans and how to open a plan yourself by visiting Sootchy online or downloading our app today.